November 23, 2011

Know why rupee is falling against dollar

The rupee slid to an all-time low of 52.73 against the US dollar on Tuesday but bounced back more than 1% on Wednesday after suspected RBI intervention.

The rupee is under pressure as foreign investors are paring their exposure to Asia's third-largest economy amid global uncertainty and mounting worries over the domestic economy.

Foreign funds sold more than $500 million worth of Indian-listed shares over the five trading sessions to Monday, reducing net inflows for 2011 to under $300 million, a tiny sum compared with the record investments of more than $29 billion in 2010.

The rupee has lost more than 14% of its value this year, making it the worst performing currency in Asia. The second-worst is the Thai baht, which has dropped only 3.5%.

Views of investors on the rupee are now at their most pessimistic in more than three years, a Reuters poll showed on Wednesday.

With the Reserve Bank of India (RBI) seen reluctant to intervene in the market to check the rupee's slide, some analysts are forecasting that the partially convertible currency will slip to as low as 55 against the dollar.

The following are some of the domestic macro-economic factors that are pushing the Indian unit down:

Slowing economic growth

India's economy emerged largely unscathed from the 2008 financial crisis and looked set to achieve its pre-crisis growth rate of 9%, attracting investments from foreign players chasing higher returns.

However, a policy paralysis in the wake of a slew of graft scandals, combined with high inflation and rising interest rates, soon began to undermine the domestic demand-driven growth story.

The annual growth rate for the current fiscal year was originally budgeted at 9% but private economists have said that growth could be well below the 8% mark.

The RBI has already downgraded its growth projection for the fiscal year ending March 2012, from an original 8% to 7.6% now. Some policymakers have begun to concede that growth in the current fiscal year could slip as low as 7%.

Worsening government finances

In February, New Delhi had budgeted a fiscal deficit, for the year ending March 2012, of 4.6% of gross domestic product on assumptions of high economic growth and low expenditure. However, a slowing economy and high subsidy spending are expected to upset those calculations, and many private economists are now predicting a full-year deficit of more than 5%.

Montek Singh Ahluwalia, the deputy head of the Planning Commission, last week conceded that meeting the budgeted fiscal deficit target would be a challenge and it was "not impossible" that the full-year deficit could swell to 5.5%.

In a global environment where investors are quick to punish fiscal slippages, the prospect of New Delhi missing its budgeted target by a full percentage point has heightened the investment risks for India.

Widening trade deficit

The external balance of any economy is seen as the biggest driver of its currency. Historically, India has been a current account deficit economy as it has been running a trade deficit.

However, it has been managing to fund its current account gap with foreign capital inflows, swamping equity markets betting on rosy prospects for economic growth. With that growth story now taking a beating, India now appears to be a relatively less attractive market for foreign investors.

In October, India had a trade deficit of $19.6 billion, its biggest in four years. the current account gap in the current fiscal year is expected to widen to 3% of GDP from 2.6% a year earlier.